Tuesday, May 15, 2018

How Central Banks Differ In Their Methods Of Calculating Inflation

My last two posts covered the uncertainty about the natural rate of unemployment. That is the lowest rate of unemployment compatible with price stability or a low level of inflation. That implies that, if the policy makers try to get the unemployment rate too low, the inflation rate will go over some target, like 2% (the Fed's target).

"It is less well understood that the inflation figures have quite
different meanings, thanks to different treatment of housing and, to a
lesser extent, health care. The most dramatic difference is housing: In
the U.S., shelter makes up a third of the consumer-price index, because
it includes an imputed rent for homeowners. In Europe only actual rents
are measured, at a weight of just 6% of the basket of goods and services
underlying the price index.

Measure both using the European approach, and overall prices have
risen the same amount since 2011. It is true that using this
measure—known as the harmonized index of consumer prices, or HICP—U.S.
prices have risen faster since last summer. But that appears to be in
large part due to energy, where the weak dollar has pushed oil prices up
faster than in Europe. There aren’t any detailed breakdowns available
for U.S. HICP, which is still an experimental statistic, but the CPI
excluding shelter, food and energy is the best equivalent to core
eurozone inflation, and exactly the same at 1.2%.

Another
indication of the importance of housing comes from the Cleveland Fed’s
median CPI, which takes the middle price rise from a ranking of the CPI
components. It drops from 2.6% to 1.7% when imputed rents are excluded,
although in recent months it, too, has accelerated.

The
Fed’s preferred inflation gauge, the PCE price index, takes a sixth of
its weight from rent and imputed rent. The gap from CPI weights is made
up mostly by including employers’ health-care costs to get a health-care
weight of a fifth. In Europe the equivalent health-care costs, mostly
borne by government, are ignored in HICP, and booze and smokes are
almost as important as health-care in determining inflation.

Statisticians have argued for years about how to include housing costs,
and they keep changing their minds. The Swedish central bank switched
its target last year to a different measure of inflation in order to
exclude mortgage rates, while the British statistical agency last year
started promoting a measure of inflation including imputed rents, with
mixed success."